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Easier credit creates competitive problems for Car-Mart

America’s Car-Mart has made a name for itself and its “drive easy” motto providing credit for used-car sales to generations of higher-risk borrowers since 1981. But, the changing dynamics in the subprime lending sector have thrown up a road block for the buy here, pay here used car dealer and finance company, according to analysts.

The Bentonville-based company has fallen short of Wall Street expectations in the past three of four operating quarters, each time citing heightened competitive issues that weighed down sales and allowed credit losses to tick upward.

Car-Mart will report its third quarter earnings on Feb. 18, and management will hold a brief earnings call the following day (Feb. 19) at 10 a.m. local time.

Wall Street expects the company to report 70 cents per share on revenue of $126.7 million. This compares to 84 cents a share on revenue of $118.9 million in the year-ago period.

COMPETITIVE HEADWINDS
Analysts polled by The City Wire this week noted that the heighten competition Car-Mart faces with each sale is not likely to soon subside as more subprime lenders continue to make credit available at perhaps lower interest rates than the 15% Car-Mart charges.

“Private equity firms and other initial public offering activity with companies like Springleaf Leasing are creating a lot of liquidity in the subprime auto and consumer credit space,” said Martin Kemnec, analyst with Jeffries, who rates America’s Car-Mart as a “hold” with a one-year target price of $38.

“While we believe in the strength of Car-Mart’s management team, they have some delicate balancing to do fending off the competition, growing sales and not incurring more risks in the process,” he said during a phone interview.

Jeff Williams, chief financial officer at Car-Mart, told The City Wire that the company believes the 15% interest rate charged to all of its customers is fair.

“We try to set everyone up to succeed and feel like the 15% is a good rate even for our very best customers,” Williams said.

That said, the company knows it stands to lose some of its better customers to other dealers willing to offer new cars at similar or even lower interest rates.

More independent lenders are making new auto loans to credit challenged borrowers and the packaging the credit pools into portfolios and selling that debt instrument on Wall Street to investors seeking higher yields.

SUBPRIME LOAN INCREASE
Total sales linked to subprime car loans surged 24.4% through August of 2013, according to Deutsche Bank. For the full year these subprime auto loans totaled $17.2 billion, just shy of the $20 billion record set in 2007.

Equifax reports that nearly one in three new car loans last year were to consumers with credit scores below 500. Analysts don’t see any pullback in this subprime growth market in 2014, which could present continued problems for Car-Mart.

The healthier funding environment reflects investors' interest in increasing exposure to subprime lending. Fitch Ratings believes there are a number of factors likely driving increased investor interest, including the favorable trends in operating fundamentals and potential for higher returns. However, Fitch warns the market is cyclical, and credit issues can emerge quickly larger problems emerge in the U.S. economy.

Wall Street investors have recently taken notice of the potential problem for Car-Mart. Shares (NASDAQ: CRMT) have tumbled 12.15% year-to-date, based on Wednesday’s closing price at $36.86 per share. It’s fair to note that the Russell 2000, a small cap index that Car-Mart is part of, is down 6% so far this year. The Dow Jones Industrials are also down 6%, while the S&P 500 has lost 4.19% since Jan. 1.

LOWER GUIDANCE
Despite Car-Mart’s aggressive plans to grow the number of dealership 10% annually, analysts with Jefferies and C.L. King recently reduced their earnings guidance for fiscal 2014 and 2015.

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Jeffries expects Car-Mart to earn 72 cents a share in the recent quarter and $2.94 for fiscal 2014 which ends April 30. Annual 2014 profit expectation compares negatively to the $3.36 per share earned in fiscal 2013. Jeffries expect fiscal 2015 earnings per share of $3.42.

C.L. King analyst Bill Armstrong recently lowered his fiscal 2014 earnings estimate by 54 cents to $3.01 for the full year. His 2015 estimate is $3.41, down from $4.08, based on the competitive pressures already noted. King said the bulk of the earnings reduction in the back half of fiscal 2014 relates to a more conservative stance on the company’s sales growth and gross margins.

“Most of the competitive financing pressure Car-Mart is feeling is at the higher end of its vehicle price range and in its more mature stores. The company is also seeing more demand for entry level vehicles and is adjusting its inventory mix accordingly. We note entry level vehicles are frequently purchased by unseasoned customers and tend to generate higher charge-offs,” King said.